Insurance Principles

1. Insurance Principles
COURSE: INSURANCE THEORY & PRACTICE
COURSE CODE: BAFI 4212
SPECIALIZATION: ACCOUNTING AND FINANCE
DEPARTMENT OF BUSINESS STUDIES

2. Learning outcome and content
Learning outcome:
Apply, explain and Evaluate the legal aspects and framework governing
the insurance contract.
Content:
 Insurance contract
Principles of Insurance

3. Essential Reading
1. From Masader:
http://search.ebscohost.com/login.aspx?direct=true&db=nlebk&AN=
1950627&site=ehost-live&ebv=EB&ppid=pp_17
2. Vaughan Emmett J., Vaughan Therese (2008), Fundamentals of Risk
and Insurance, 10th edition, John Wiley & Sons, Inc.

4. CONTRACT
Contract: is an agreement between two parties or more to create a legal
binding relationship.
Essentials of general contract:
Offer and acceptance
Consideration (act or the promised offered by both parties e.g. premium & compensation)
Legal Capacity to contract ( both should have the capacity to enter into a contract e.g. following
the low, legal age, sound mind)
Consensus (genuine meeting of mind i.e. both understand each other)
Capability of Performance
Legality of Purpose ( the contract is for legal purpose e.g. insurance for stolen property or any
illegal activity such as gambling)
Intention to create legal relationship ( intend to create a legal relation and understand that
agreement can be forced by law)

5. INSURANCE CONTRACT
Insurance contract: a contract where the insurer promise to
compensate the insured on the happening of specific event.
Important terminologies:
Insurer
Insured
Subject Matter
Premium

6. PRINCIPLES OF INSURANCE
Principle of uberrimae fidei (utmost good faith),
Principle of insurable interest,
Principle of indemnity,
Principle of contribution,
Principle of subrogation,
Principle of loss minimization, and
Principle of causa proxima (nearest cause).

7. Utmost Good Faith
Insurance contract must be signed in an absolute good faith.
The insured must Disclose and provide all important information about
the subject matter that might effect the insurer decision.
The insurer's liability gets void if any facts, about the subject matter of
insurance are either omitted, hidden, falsified or presented in a wrong
manner.
Applies to all types of insurance contracts.

8. Example
A landlord at the time of proposal has disclosed that the building is
rented out and is being used as an office. If during the continuation of
the policy the tenants vacate the building and the landlord
subsequently rents it out to a person using it as a warehouse then he is
required to disclose this fact to the Insurer as this is a change in
material facts and effects the risks.
Mr. John a tax practitioner, took a medical insurance policy form AXA
gulf. He did not mentioned in the proposal form that he had some
serious medical issue two years back as he feel disclosing that
information to insurance company may leads to rejection of his
proposal or he has to pay extra premium.

9. PRINCIPLE OF INSURABLE INTEREST
Insured must have an insurable interest on the subject matter (i.e. he
should benefit from the safety of the property and suffer financially by
its loss).
Insurance interest: Ownership and benefit.
The insured must be in a relationship with the subject matter of
insurance, whereby he benefits from its safety and well-being would be
prejudiced by its loss or damage.

10. Example
Ownership plays a very crucial role in evaluating insurable interest. For
Example:
•Every person has an insurable interest in his own life.
•A merchant has insurable interest in his business of trading.
•A creditor has insurable interest in his debtor.
•The owner of a taxicab has insurable interest in the taxicab because he
is getting income from it. But, if he sells it, he will not have an insurable
interest left in that taxicab.

11. PRINCIPLE OF INDEMNITY
Indemnity means security, protection and compensation given against
damage, loss or injury.
The objective of insurance is to protect the insured against the loss and to
place the insured in the same financial position as he was before the risk.
The contract is not made to make profit.
Insurance contract is signed only for getting protection against unpredicted
financial losses arising due to future uncertainties, not for earning profit.
The amount of compensation is a proportion to the incurred loss and it is
limited to the amount assured or the actual loss which ever is less.
This principle is not applicable to life insurance because the value of human
life cannot be measured in terms of money.

12. Example
Mr. Ali purchased a fire insurance policy with a Sum Assured
RO. 10,000. The value of his house is RO 20,000. A fire
happened in his house and the estimated loss is RO 15,000.
How much Mr. A can claim from the insurance company?

13. PRINCIPLE OF CONTRIBUTION
Principle of contribution is a corollary of the principle of indemnity
this is applicable when the insured has more than one insurance policy
for the same property (subject matter).
The insured can claim the compensation only to the extent of actual
loss either from all insurers or from any one insurer.
If one insurer pays full compensation then that insurer can claim
proportionate claim from the other insurers.
Insured cannot make a profit from any of insurance contract.

14. Example
Mr. Anwar insured his car for a RO 10,000 SA with Muscat
Insurance and the same car he insured for a RO 15,000 SA
with AXA insurance. An accident happened and the
estimated loss is RO 8,000. How much he can claim?

15. PRINCIPLE OF SUBROGATION
Subrogation means substituting one creditor for another
After the insured is indemnified the insurer has the right to
claim for the compensation from the 3rd party who cause the
loss.
This is because the ownership right of the property shifts to
the insurer according to this principle.
The insurer can benefit out of subrogation rights only to the
extent of the amount he has paid to the insured as
compensation
When the insured is compensated in full for the loss of an
insured property, then the ownership right of such property
shifts to the insurer.

16. PRINCIPLE OF SUBROGATION
The objective of principle of subrogation is:
To prevent the insured from profiting from the
damage.
Guilty party should pay for the loss.
The insurer can recover the amount paid for the
loss.

17. Examples
Mr. Ali insured his car for RO 15,000 with Muscat insurance. There was an
accident and the entire car got damaged. The car cannot be repaired and
can only sell as scrap. Since the car cannot be repaired insurer decided to
pay a total compensation of RO 15,000 to Mr. Ali. The insurer estimated the
value of the scrap as RO 1,000. Now the ownership of this scrap moved to
insurer after paying a total loss.
Mr. John insured his boat for RO 25,000 with AXA insurance. A foreign ship
collide with his boat and the entire boat was capsized. The police authority
found that the accident happened because of negligence of the captain of
the ship. Mr. John claimed the compensation from AXA and AXA paid the
total compensation of RO 25,000 to Mr. John.
Since the claim caused to the insurance company due to the act of a third
party( Ship), AXA can claim the same from the owner of the ship or
insurance company where the ship is insured.

18. PRINCIPLE OF LOSS MINIMIZATION
Under this principle:
The insured must take all possible measures to reduce the extend of
loss.
Insured must not neglect the accident.
Insured is responsible to protect his property and prevent further loss
for it.
This principle is to protect the interest of the insurance company.

19. EXAMPLE ON PRINCIPLES OF LOSS
MINIMIZATION
Mr. Salim purchased a fire insurance policy for RO. 2 million for his old
shop. A fire happened in his shop and he knew that it is going to spread
to the entire shop and damage the stocks. Since he is aware that
insurance company is going to compensate, he did not even venture out
to set off the fire. He did not call fire brigade which is located just half a
kilometer from his place. Entire shop was damaged due to the fire.
While assessing loss to Mr. Salim property, the insurance company’s
officer found these inaction of Mr. Salim in a CCTV camera installed
Can insurance company reject his claim? Substantiate your answer.

20. CAUSA PROXIMA
(NEAREST OR IMMEDIATE CAUSE)
When the loss is caused due to more than one causes or a series
of causes, the insurance company must determine the
closest/nearest cause while deciding the liability of the insurer.
The asset may be insured against some Cause but not all. In this
case, the proximate cause has to be found. (only If the proximate
cause is insured, the insurance company is obligated to pay the)

21. EXAMPLE ON APPROXIMATE/NEAREST
CAUSE
Example: A policy covers accidental fire but specifically excludes
earthquake fire. There is an earthquake fire somewhere near the
insured building. Due to the prevailing wind, the fire spreads gradually
to neighboring buildings one after another and ultimately sets the
insured building into the fire. Can they claim for the property damage?
Answer:
The claim is not payable because the proximate cause of loss is
earthquake fire and not ordinary fire even though the earthquake had
nothing to do with the insured building.
This is so because throughout the spread and travel, with the help of
natural wind, the fire retains its identity as earthquake fire. The
situation would have been different had the spread of fire been
interrupted by a new and independent cause.

22. Example 2
An ordinary fire policy was given to cover a warehouse and the policy
excluded war or warlike operations etc. The warehouse was completely
damaged by fire arising out of a bomb being dropped from an enemy
aircraft.
The insurer repudiated the liability on the ground that even though
the warehouse was damaged by fire, the proximate cause of the
damage was a warlike operation (i.e., enemy action) and the fire was
simply a remote cause. The judgment was given in favor of the insurer
maintains that the loss was proximately caused by an enemy action
which was not covered by the policy (ROGERS V. WHITTAKER (1917))

23. CONTACT INFORMATION:
Name of the Staff: Eman Al-Hinaai
Office: 24473818
Email: eman.alhinaai@hct.edu.om
Version History:
Version No. Date Approved Changes incorporated
1 Sem.2 (19/20)May, 2020